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The Stock Repair Strategy – Part 4 of Options Trading for All Types of Market Environments

Friday, September 9th, 2011

Part 4: The Stock Repair Strategy

The Stock Repair Strategy is the options trading strategy designed to “repair” a stock account that has suffered from capital loss due to a drop in price.

This strategy allows the loss to be recovered with a moderate rise in the price of that stock. For example, if you bought shares of AAA company and it has dropped significantly since you bought it, say 10%, you could use the Stock Repair Strategy to recover that 10% loss as long as AAA company stock rises about 5%. I’m sure “buy and hold” investors would have a number of likely candidates for this strategy in their portfolios.

The Stock Repair Strategy - is designed to use stock options, with limited risk, to quickly recover the loss from a drop in the share price.

Use the Stock Repair Strategy to recover losses in your stock position when that stock is expected to rise moderately. If you are of the opinion that the sell-off in a stock has finished and the stock is likely to bounce from current levels, then the Stock Repair Strategy can help you “repair” a stock account which has suffered from capital loss due to a drop in price, in double quick time.

The Stock Repair Strategy is achieved through buying 1 contract of at the money (ATM) call options for every 100 shares you own and then writing twice as many out of the money (OTM) call options at a strike price where the total proceeds cover (or nearly cover) the amount spent on the at the money (ATM) call options.
Therefore the Stock Repair Strategy does not cost anything to put on (apart from transaction fees of course) and requires no margin. This makes this strategy ideal for anyone who expects the stock price to recover near term and wishes to quickly recover losses sustained in a stock position.

Traders can use this strategy to double up their position with minimal risk and minimal cost. However any gains are capped to the upside at breakeven, so that you would exit the original position flat, and you do not get any protection on the downside. Having this position in place is an excellent way to quickly recuperate stock losses at no extra cost, if the stock rallies all the way to the strike price of the short call options.

Advantages and Disadvantages

The Stock Repair Strategy has its advantages as it can bring your stock position back up to breakeven, so as long as stock rises moderately. There are minimal costs to place the position and it requires no margin.
However it has the disadvantage of cutting profits at breakeven, so that no further profits can be obtained if the stock rallies beyond the strike price of the short OTM calls.

Example Trade – ANZ Bank

ANZ traded between $21.00 and $22.00 for over a month through to mid-June, and was trading on a grossed up yield of over 9 percent. If you had purchased the ANZ stock on a breakout you could be holding the stock at a cost of around $22.05. There have been some wild gyrations over the subsequent months, but for those “buy and hold” investors there is still hope: utilise the Stock Repair Strategy to recover losses in your stock when that stock is expected to rise moderately near-term.

The stock repair trade for ANZ was priced on September 7th 2011 when the October options had 48 days until expiry and ANZ shares were trading at $20.10.

Trade Details:
Buy 1 contract of at the money (ATM) 2000 Oct11 call options (for $0.96/contract) for every 100 shares you own and then write (sell) 2 of the 2100 OCT11 out of the money (OTM) call options (at $0.46/contract) for every 100 shares you own.

This trade costs 4 cents/contract to place and if you are exercised you will sell youf original share parcel at $22.00 (5 cents shy of the purchase price). Note cost calculations do not include associated transaction costs.

Chart 1: ANZ Stock Repair Trade

You can plan and analyse your trade as shown above, using the Derivative Profiler function in the Market Analyser software.

Trade Note

The Stock Repair strategy simply involves buying 1 contract of at the money (ATM) call options for every 100 shares owned and then writing twice as many out of the money (OTM) call options. The Stock Repair strategy costs next to nothing to put on and if the stock drops further, the ATM calls simply expire with the OTM calls, which completely offset each other, causing no additional losses to your original stock position. This strategy reaches its maximum profit potential when the stock price is equal to or greater than the strike price of the out of the money (OTM) options.

The goal of the ANZ trade is for ANZ to be trading above $21.00 at the October expiry, so that the position is repaired with minimal or no loss. Please note that ANZ is due to go Ex-div around 4 Nov’11 around $0.74 cents per share, so if the stock does not get exercised, then the dividend will offer some comfort.

Using the Stock Repair Strategy, the stock needs only move up by 5% to reach breakeven, however the stock could drop 10% and the position’s loss would be the same as if the Stock Repair Strategy was not implemented.

The Trade

Options can be used in order to reduce your risk while still participating in potential profits from a significant move by the underlying stock. Today we’ve explained the Stock Repair Strategy which allows you to “double down” on your current losing position for minimal cost, however your profits will be restricted to breakeven on the trade. Note this strategy does not offer any protection to the downside.

In future articles we will talk about the High Yield Covered Call strategy and the High Yield Covered Put strategy, which is particularly relevant to this market.

Utilise the features in the Market Analyser software to trade plan your options trades for the particular options strategy using your specific trade selection criteria. You will save time and potentially reduce your trading risk.

By Michael Hevern
Head of Research

For Buy and Sell recommendations on ASX listed companies register for a free trial of MDS Financial Research.

MDS Financial Advisory Services offers general advice on trading options to generate consistent steady income on your investment portfolio. Call 1300 610 024 for further information.

Tags: ANZ Bank, at the money, Financial Advisory, in the money, options, options trading, Trading Strategy
Posted in Stock Market Analysis | No Comments

The Covered Call Collar – Part 3 of Options Trading for All Types of Market Environments

Friday, August 12th, 2011

Part 3: The Covered Call Collar

The Covered Call Collar is an options trading strategy that traders can use to protect an existing position that has recently surged into a key resistance level. Rather than simply taking profits on the share position and potentially missing out on future upside, the trader enters into a Covered Call Collar. This options trading strategy seeks to protect your existing share position while still participating in some of the upside for a minimal or no outlay.

The Covered Call Collar allows you to participate in some of the future gains up to the sold strike price, while being protected by the put position.

Covered Call Collar: ideal for participating in future gains, while being protected on the downside.

If you are of the opinion that the stock is likely to sell-off with little chance of breaking the key resistance level, but you still want to hold on to it, you could use a Covered Call Collar options strategy. The Covered Call Collar strategy is similar to the protective put options strategy in that you also buy put options as protection. The difference is that you will now finance the purchase of those put options with the proceeds from writing an equal number of out of the money call options.

The position will still protect you from losses below the strike price of the put options at minimal to no cost to yourself, but it will also stop the position from profiting beyond the strike price of the short call options should the stock stage a rally. That is, you would miss out on a strong rally in exchange for putting on the protection of the put options for next to no cost (apart from commissions, of course).

Use a Covered Call Collar when you expect the share price to move modestly higher or pull back significantly from current levels.

Recent Trade: Newcrest Mining (NCM)

A recent trade which is yet to pay off was Newcrest Mining. We initially entered the share position when the stock price broke above its 50 and 200 day moving averages, around $38.50. It shot up soon after we entered the trade and has now been trading sideways for the past few weeks. We considered a covered collar was appropriate for this position. Based on technical analysis you can see from the chart that the $42.50 resistance level has held for over a year.

So we bought protection at $39.00 by buying 3900 SEP11 Put for $0.645 and then wrote the $42.50 SEP11 Calls for $0.775. We received a credit for this trade and the position remains open. We are protected until September expiry down to $39.00 and profits will be capped at $42.50.

Chart 1: Newcrest Mining Covered Call Collar Trade

You can plan and analyse your trade as shown above, using the Derivative Profiler option in the Market Analyser software.

MarketAnalyser also provides a payoff diagram for further trade analysis as follows:

Chart 2: The payoff diagram for the Newcrest Covered Call Collar trade.

Trade Note

Newcrest (NCM) is still trading between the $39.00 and $42.50 option strike levels and only time will tell whether the share price will end up at expiry, but we are protected until September expiry down to $39.00 and profits will be capped at $42.50.

The Trade

Options can be used in order to reduce your risk while still participating in potential profits from a modest move in the underlying stock. Here we’ve explained the Covered Call Collar strategy which allows you to participate in some of the future gains up to the sold strike price, while being protected by the put position.

In future articles we will talk about the High Yield Covered Call strategy and the Stock Repair strategy which is particularly relevant to this market.

Utilise the features in the Market Analyser software to plan your trades for the particular options strategy using your specific trade selection criteria. You will save time and potentially reduce your trading risk. Sign up for a free 14-day software trial here.

By Michael Hevern
Head of Research

For buy and sell recommendations on ASX listed companies register for a free trial of MDS Financial Research.

MDS Financial Advisory Services offers general advice on trading options to generate consistent steady income on your investment portfolio. Call 1300 610 024 for further information.

Tags: covered call, Financial Advisory, Market Analyser, Newcrest Mining, options, options trading, Trading Strategies
Posted in ASX Trading News, Trading Strategies | 1 Comment

The Covered Call – Part 2 of Options Trading for All Types of Market Environments

Friday, July 22nd, 2011

Part 2 – The Covered Call

The Covered Call, also known as a Covered Buy Write or Covered Call Write, is the options trading strategy that most beginners learn about. It is a strategy which seeks to make a monthly income by selling call options against existing stock holdings.

The Covered Call allows you to generate a regular monthly “rental” income on your current stock portfolio, even when the stock prices remain stagnant. The Covered Call can also be used to protect against a moderate short term drop in stock price, to a limited extent. These characteristics make the Covered Call an attractive options trading strategy for all traders who hold long term stock positions.

Use a Covered Call when you wish to hold on to a stock that is trading sideways to slightly higher, while making a monthly income from it. You can also use a Covered Call to protect your equity when the stock goes into a slight correction, but only to a specific price limit. A Covered Call consists simply of writing 1 contract of out of the money call options for every 100 shares of the underlying stock owned.

The Covered Call is ideal for generating a regular monthly “rental” income from your current stock position.

A recent trade that paid handsome dividends was Fosters, which we entered when there was takeover speculation, back in June.

We bought Fosters at $4.55 and wrote the $4.65 Jul11 Calls for $0.22 and closed the position on the 22^nd of June 2011 after the takeover bid was announced, for a tidy 7% profit.

Investors who took advantage of our High Yield Covered Call strategy actually made 30% on the same trade. This strategy will be discussed in a later article, or you can call me on 1300 610 024 to talk about it further.

Chart 1: Fosters Covered Call Trade (Took Profits on Takeover Announcement)

Covered Call Profile

You can plan and analyse your trade as shown above, using the Derivative Profiler option in the Market Analyser software.

Trade Note

We could have made a higher return on the trade if we just bought the stock (14% return), but by using the Covered Call strategy we reduced our risk as we were being paid $0.22 or 5% to wait for the bid to come along. At the time we entered the trade Fosters was saying that they had not been approached by any interested party.

The Trade

Options can be used in order to reduce your risk while participating in the profits from a significant move by the underlying stocks. Here we’ve explained the Covered Call strategy which is used to generate monthly “rental” income from your current stock position.

In future articles we will talk about the Covered Call Collar strategy, which is similar to the protective put options strategy in that you also buy put options as protection, and the Stock Repair strategy which is particularly relevant to this market.

By Michael Hevern
Head of Research

Viewing Options through The Bourse

Friday, September 3rd, 2010

In last week’s Analyst’s Eye article we considered the standardisation of options. This standardisation is important so that it is easy to understand exactly what it is that you are trading. Every option has an underlying share, is a call or a put, has an exercise price and an expiry date and the price you pay for the option is the premium.

With these five pieces of information in mind let’s consider a trade on ANZ below. We will consider trading a put option in this example, however the process of trading a call is identical if you believe a share is going up, instead of down.

Taking (Buying) a Put

You would buy a put if you believe the share is going down. Buying a put gives you the right to sell 1000 of the underlying share at an agreed price on, or before, an agreed date.

Call or Put

We have chosen the share we wish to trade which in our example is ANZ Bank. We believe from our analysis that ANZ is likely to fall from its current price. ANZ was trading at $23.34 on 2 September 2010. We could therefore buy a put option on ANZ.

The Bourse - Insight - ANZ chart

So we now look up the put options available for ANZ. As an example through The Bourse charting software, on the toolbar and click the red O toolbar icon, for Exchange Traded Options. We have a choice of expiry dates and exercise prices to make before we can determine the premium (cost) of the option.

Type in the code of the share, which in our case is ANZ, and then select Put to display a list of Put options that are available on ANZ. You will see a list with different expiry dates in the month column, and different exercise prices in the Strike column. The most actively traded options will be near the current price, which is around $23.34.

The Bourse - Insight - ANZ Options

Expiry Date

For any option position you must choose the expiry date you wish to trade. At any given exercise price there is a range of expiry dates. The expiry dates start on Oct 2010 which is about three weeks away, and go all the way out to 2014. The more time an option has until the expiry, the more expensive it will be.

As a guideline option traders would normally take options with between six weeks and three months until the expiry. So on the 21st of July 2010 an options trader would normally consider an expiry date of September the same year. Remember you must allow the share time for the expected move to occur. Most of the time decay for an option occurs during the last month so let’s take a look at the November expiry dates.

Exercise Price

Now we can select the exercise price we wish to trade.

The Bourse - Insight - ANZ Options 2

With ANZ trading at $23.34 the closest exercise price is $23.50. This would be regarded as the at-the-money option. The $23.00 option is out-of-the-money and the $24.00 option is in-the-money.

An in-the-money option costs more than an out-of-the-money option and is lower risk. The in-the-money option already has some intrinsic value, while the out-of-the-money option is all made up of time value. The different options will behave differently based on the movement in the share.

Premium

It will depend on which option you choose as to the premium that you pay for the option. Assuming that you chose the $23.00 November Put option and you bought the option at market price, you would pay a premium of $1.12 per share. Remember that each option contract is for 1000 shares so the cost of 1 option contract would be $1.12 x 1000 = $1120.

The success of the trade will be determined by the movement of the underlying share, but will also be affected by your choice of option. We will consider three different options and how they perform in different scenarios.

Possible Outcomes

There are three possible outcomes: the share is higher, lower or goes sideways. The change in the price will be determined not only by the direction of the move, but also by how quickly the move occurs. The option is a wasting asset, and the time value decreases as time passes.

Share Moves Down

All put options will increase in value, with the out-of-the-money option increasing the most. The out-of-the-money option could move into-the-money which would result in a sharp increase in value. Call options would decrease in value as the share moves down.

Share Moves Up

All put options will drop in value with the sharpest drop shown in the out-of-the-money options. The chance of the out-of-the-money option having value on, or before the expiry date, has become much less, and consequently the value of the option will drop dramatically. Call options behave in the reverse, with prices rising.

Share Moves Sideways

All options drop in value as time passes, regardless of whether they are puts or calls. Options are decaying assets and lose time value every day they are owned.

The out-of-the-money option will normally provide the biggest return coupled with the biggest downside if the trade does not go in the direction the trader expected.

Trading Puts

There are two main reasons that a trader would trade put options. The first is if the trader wanted to profit from a fall in value in the share. A put option increases in value as the underlying share falls, allowing a trader to buy the options and sell it at a higher price.

Put options, like call options, are wasting assets. The trader must pick both the direction and timing to enter the trade. Strong returns can be made trading put options when shares fall away rapidly, as they did in January 2008. It is important that the expiry date that is chosen provides the trader with enough time for the move to play out, so they can benefit from it. A share moving sideways or upwards is going to cost the trader money.

Investors may want to employ put options as a protection mechanism for their portfolio. The put option increases in value as the share drops, but it also gives an investor the right to sell their shares at the exercise price. If you owned WBC shares and were concerned that the shares might drop, you could purchase put options as protection.

If you were correct and WBC did drop you now have the right to sell WBC at the exercise price of the put option. Alternatively you could sell the put option for a profit and continue to own the shares. This is known as hedging.

Adding put options to your trading toolkit offers you the flexibility to profit in different market conditions. Share traders are limited to making money from a rising share price, but options traders just want the share price to move.

By Jeff Cartridge
Education Manager

Sign up for a FREE trial of The Bourse today

The information provided within this blog is general advice only and you should consult the services of a financial professional in order to ascertain whether the information is applicable to your investment strategies and risk profile.

Tags: ANZ, call options, options, options trading, put options, shares, the bourse, Trader Dealer, trading puts, WBC
Posted in Trader Dealer News, Trading Software | 1 Comment

Word from the nerd

Wednesday, June 17th, 2009

Development on our new systems for providing Market Data is coming along well. The team has spent the last month integrating broking support into the system. It s now possible to create/amend/cancel orders and to view holdings and cash account information through the new system.

Furthermore, the system now supports accepting market data from a variety of sources, but making them available all from within the same standard environment. This means that we can push in Futures, Options, Equities, FX and Commodities data from many differing points of origin, but have our software products handle them with little customisation or specialisation.

Finally, the first prototypes of the web based streaming version of the products that use the new Market Data system have been demonstrated; with proper development expected to commence shortly.

Tags: Commodities, Forex, investment in equities, market data, market data software, options trading
Posted in Trader Dealer News | No Comments

Get Rich with Options – Book Review

Wednesday, June 17th, 2009

Get Rich with Options –

Four Winning Strategies Straight from the Exchange Floor

Author: Lee Lowell

Book Review

Any book that has the title Get Rich makes me wonder who is actually getting rich in the process, the reader or the author!
After getting excited about the prospect of getting rich I opened the book up to the first page where it states You can reap returns of 100% to 500% per trade and immediately my alarm bells start ringing!

This isn t the type of book I would recommend for anyone who has never had any experience in options and is looking to get their hand held with learning the ropes of options from the beginning. It delves into the more complex components of option trading which suits the intermediate traders and those looking to better understand the mechanics of how options work.

One thing to keep in mind that the book is written in the US so all options contracts are of different size and that their market is a lot more complex and liquid than the options market in Australia.

Looking past the ego stroking which tends to pad out most chapters, I was pleasantly surprised to see Lowell describing how options actually work! After reading several other books on option trading, Lowell has successfully provided a clear and concise explanation of volatility and the Greeks and how they affect option prices and trading strategies, which provides valuable information to anyone who is serious about option trading.

The book is broken up into three distinct sections. The first section focuses on the basics; the second part covers four strategies with a bonus fifth strategy thrown in for good measure and the third section talks about getting ready to trade.

Overall the book is well written and is a relatively short read. The examples used in the book are of a high quality and are obviously taken from real market situations.

Rating of 6/10

Reviewed by Tom Boland
Manager, Trader Dealer

To buy this book now at the Educated Investor Book Shop, click here.

Tags: finance books, Get rich with options, options trading, review
Posted in Trader Dealer News | No Comments

Short-selling ban lifted early

Monday, May 25th, 2009

The ban on the covered short-selling of financial stocks will be lifted today, five days before the scheduled expiry date.

ASIC imposed the ban eight months ago, in an effort to curb the market volatility prevalent in the wake of the Lehman Brothers collapse. But today the regulator has announced the conditions are favourable for a return to covered short sales.

The ban on covered short selling of most non-financial securities was lifted in November.

To read ASIC s statement, click here.

To find out more about using covered calls as part of your trading strategy, visit the Trader Dealer website.

Tags: ASIC, covered call, finance news, options trading, short sell, Trading Strategies
Posted in ASX Company News | No Comments

Posts Tagged ‘options trading’

Part 4: The Stock Repair Strategy

Advantages and Disadvantages

Example Trade – ANZ Bank

Trade Note

The Trade

Part 3: The Covered Call Collar

Covered Call Collar: ideal for participating in future gains, while being protected on the downside.

Recent Trade: Newcrest Mining (NCM)

Trade Note

The Trade

Part 2 – The Covered Call

The Covered Call is ideal for generating a regular monthly “rental” income from your current stock position.

Trade Note

The Trade

See Also:

Taking (Buying) a Put

Call or Put

Expiry Date

Exercise Price

Share Moves Down

Share Moves Up

Share Moves Sideways

Trading Puts

Get Rich with Options –

Four Winning Strategies Straight from the Exchange Floor

Author: Lee Lowell

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